Assignment report Economics Analysis

Ibrahim Saheshan Ali (ac3620) Economic Analysis for business _Report

1

AVID COLLEGE Assignment Cover Sheet

Student Details

Student Name: Ibrahim Saheshan Ali Student ID: ac3620

Contact Number: 7791193 Email Address: [email protected]

Scheduled Unit Details

Unit Title : Economic Analysis for Business Word Count: 4408

Unit Enrolment Details : Year (yyyy) 2015 Semester (S)

Lecturer : Fathimath Saeed

Assessment Details

Assignment Name: Effects of Plunging oil prices

Due Date : 10th December 2015 Date Submitted: 8th December 2015

Extension Granted?

No

Yes – Lecturer’s Extension Date:

Yes – Department Extension Date:

Is this a resubmission?

No

Yes Resubmission Date :

Declaration

I Ibrahim Saheshan Ali here by certify this assignment is my / our own work based on my / our personal study and / or research I/ we have acknowledge all material and source used in the preparation of this assignment. I/ we also certify that the assignment has not been submitted for assessment in any other subject or at any other time in the same subject and that I/we have not copied in part or whole or otherwise plagiarized the work student and / or other person

Name: Ibrahim Saheshan Ali Signature: Date: 8th December 2015

For Office Use Only :

Receipt date: Received By: Signature:

*Note: Late submission without any approved extension; MVR1000 AND 10% Deduction from total marks Late submission with prior extension; MVR500 with 5% Deduction from total marks

Keep this with Students

Student Name: Submitted Date: Time:

Assignment Name : Course Name:

Received by: Sign: Date:


2

ECONOMIC ANALYSIS FOR BUSINESS

EFFECTS OF PLUNGING OIL PRICES

Ibrahim Saheshan Ali

MBA (Strategic Management) Avid College

10th December 2015


3

Table of Contents

1. Abbreviations 4

2. Abstract 5

3. Introduction 6

4. The effect on prices of automobile in US market as a result of plunging oil prices 7

a. Oil demand and supply 7

b. Oil production & prices 9

c. US automobile industry 10

d. Effects on the prices of automobile 11

5. The impacts of oil prices on the Malaysian economy 13

a. Malaysian oil industry 13

6. Effects of depreciating Ringgit value & inflation on Malaysian economy 17

a. Demand pull inflation 18

b. Malaysia’s inflation rates 18

c. Cost push inflation 19

7. Negative effects of plungging oil prices & Ringgit value & inflation on Malaysian economy 20

a. Expansionary monetary policy 22

b. Contractionary monetary policy 23

c. Expansionary fiscal policy 23

d. Contractionary fiscal policy 24

e. Macroeconomic policy mix 24

8. Externalities of provision of eductaion, tourism and healthcare in Malaysia 26

a. Positive externalities of education 27

b. Positive externalities of tourism 27

c. Positive externalities of health care 27

9. Conclusion 29

10. References and sources 30


4

ABBREVIATIONS

The main abbreviations used in this report are as follows:

OPEC (Organization of petroleum exporting countries)

OECD (Organization for economic co-operation & development)

IEA (International energy agency)

MPC (Malaysia Productivity Corporation)

Mb/d (Million barrels per day)

Tb/d (Thousand barrels per day)

4Q14 (4th Quarter in 2014)

3Q15 (3rd Quarter in 2015)

NGL (Natural gas liquids)

FSU (Former Soviet Union)

PSC (Production Sharing Contract)

SMB (Social marginal benefit)

PMB (Private marginal benefit)

SMC (Social marginal cost)

PMC (Private marginal cost)

GDP (Gross domestic product)


5

ABSTRACT

This is an economic analysis report entitled as “effects of plunging oil prices”. The main objective of this

report is to analyze the effects of plunging oil prices on the Malaysian economy and on the US automobile

production and demand. This is a systematic approach to determine the changes in global oil production,

demand and supply. The changes in the prices of oil in the global market and the effects of the plunging

prices on the Malaysian economy have been identified and analyzed through relevant online sources.

This analysis is done through online research on the world oil market, OPEC and Non-OPEC production,

demand and supply. The tool for this analysis is relevant official websites providing required official

information about the industry world-wide. Central bank’s statistics are considered in measuring the

depreciating value of the Malaysian Ringgit and its effects on the whole economy.

Charts and tables are incorporated for better understanding and ease of comparison.

The study and analysis states that the plunging oil prices are highly influential to Malaysian economy and the

total GDP. The depreciating Malaysian currency is affecting the economy adversely, and if not countered

efficiently can lead the economy into a recession.


6

INTRODUCTION

This economic analysis is done on the effects of plunging oil prices on Malaysian economy and the US

automobile industry.

The total demand and supply for oil and oil growth in the year 2015 is studied along with the demand and

supply in the US through OECD, Non-OECD and OPEC production. The global oil production and prices

are studied and the effects on the US automobile industry are forecasted in this report along with the possible

effects on the prices of automobiles in the US market.

The impacts of oil prices on the Malaysian economy is discussed after studying the country’s oil production,

exports and imports, and other industrial activities that contributes to the economy.

The effects of depreciating currency value and the inflation in the economy is discussed along with the

factors that may cause the currency value to fall and the types of inflation and its chances to impend to a

recession.

After studying the types, level and reasons for the growing inflation in Malaysian economy, a

macroeconomic policy mix is suggested which can tackle the current economic issues in Malaysia.

Some of the economic activities carried out in the Malaysian economy that contributes to the GDP have been

highlighted in this report with the possible externalities resulting through their existence. The

recommendation for the government to subsidize on these activities is mentioned after identifying the

positive and negative externalities produced by these activities.


7

The effect on prices of automobiles in US market as a result of plunging oil

prices

Oil demand & Supply

OPEC (2015) states that Oil demand growth in

2015 was foreseen to rise by 1.50 mb/d. Total

oil demand is forecasted at 92.86 mb/d.

Non-OPEC oil supply growth in 2015 stands at

0.72 mb/d. In September, OPEC crude

production increased by 109 tb/d to 31.57

mb/d.

8788899091929394959697

1Q

20

13

2Q

20

13

3Q

20

13

4Q

20

13

1Q

20

14

2Q

20

14

3Q

20

14

4Q

20

14

1Q

20

15

2Q

20

15

3Q

20

15

4Q

20

15

1Q

20

16

2Q

20

16

3Q

20

16

4Q

20

16

mb

/d Total Oil DemandProjections for

2016

(Source: OPEC.org)

World Oil Demand by main region, y-o-y growth 2013 - 2014

(Source: OPEC.org)


8

According to IEA (2015) the

average demand in 2015 is

higher than the supply except for

the FSU. This shortage can

occur due to the plunged oil

prices. Krauss’s (2015) article

states that the oil industry is in a

new downturn, due to the

plunging prices per barrel which

has been cut roughly in half

since June 2014, reaching levels during the depths of the 2009 recession.

0

5

10

15

20

25

Americas Europe Asia Oceania

Demand 24.5 13.8 8.1

Supply 19.6 3.4 0.5

MB

/D

Average Oil Demand & Supply

(OECD 2015)

4.8

0.7

11

12.5

6.9

8.2

4.1

13.9

0.1

4.33.6

4.6

1.2

2.3

0

2

4

6

8

10

12

14

16

FSU Europe China Other Asia Americas Middle East Africa

MB

/D

Average Oil Demand & Supply (Non-OECD) 2015

Demand Supply

(Source: IEA.org)

(Source: IEA.org)


9

Oil production & prices

IEA (2015) states that Global

production has dropped by 0.60

mb/d in august 2015. Crude oil

supply fell by 220 kb/d & Non-

OPEC production declined by

350 kb/d.

According to IEA (2015) The

plunge in global crude prices are

expected to cut non-OPEC oil

production by nearly 0.5 mb/d next

year, on a sharply weaker outlook for US supply, lower Russian output and structural declines in the North

Sea.

OPEC (2015) states that, the OPEC Reference Basket averaged $44.83/b in September, declining 63¢ from

the previous month. ICE Brent averaged $48.54/b, a gain of 33¢, and Nymex WTI averaged $45.47/b, up

$2.58. The Brent-WTI spread narrowed from $5.32/b to $3.07/b.

Asia Oceania

Europe

Americas

0

5

10

15

20

1Q15 2Q15 3Q15 4Q15

0.43 0.44 0.51 0.49

3.41 3.5 3.32 3.35

19.88 19.57 19.47 19.59

MB

/D

OECD Oil Production 2015

Asia Oceania Europe Americas

0

2

4

6

8

10

12

14

16

1Q15 2Q15 3Q15 4Q15

14.05 13.98 13.9 13.86

7.9 7.96 7.91 7.96

0.14 0.14 0.14 0.13

4.63 4.55 4.52 4.57

1.3 1.23 1.2 1.182.32 2.3 2.25 2.26

MB

/D

Non-OECD Oil Production 2015

Former USSR Asia Europe Americas Middle east Africa

(Source: IEA.org)

(Source: IEA.org)


10

(Source: EIA.gov)

US Automobile industry

SELECTUSA (2015) states that USA has

one of the largest automotive markets in

the world and is home to 13 auto

manufacturers, which has produced an

average of over 8 million passenger

vehicles annually.

The declining crude prices may deeply

impact on automobile production since,

(Varjavand, 2015) article states that USA

spends nearly $1.5 trillion on crude oil,

more than 8% of its GDP every year.

Production of vehicles has increased since 2011 due to the fall in cost of factors of production thus increasing

the supply. The demand tends to increase due to lower prices of vehicles & lowering petroleum prices.

0

5

10

15

20

25

OECD Non-OECD

24.5

6.9

19.6

4.6

MB

/D

Average Oil Demand & Supply (USA)

2015

Demand Supply(Source: IEA.org)


11

Effect on the prices of automobile

Changes in demand and supply can impact on the automobile prices in the US market. For example:

When the prices of petroleum

plunged, the disequilibrium took

place at P* & Q*, excess

demand forced a new

equilibrium at P1 & Q2

increasing the price.

0

2

4

6

8

10

12

2011 2012 2013 2014 2015

8.67

10.3811.1

11.7 12

Mill

ion

s

Year

Vehicle Production 2011 - 2015 (USA)

Number of vehicles

(Source: Statista.com)


12

When the price was $120/

barrel the production

where 20000 automobiles.

At the price of $110/barrel,

production increased to

25000, thus resulted excess

supply.

The equilibrium took place

at P* & Q*. Due to the

plunge in prices of oil and

vehicles, the excess demand

increased the price, forcing a

new equilibrium at P1 & Q1.

At the same time the effect of

excess supply resulted prices

to drop and quantity

increased from Q1 to Q2.

Now the final equilibrium

forms at P* & Q2.

Hence, the final effect is that the prices will be questionable and the quantity supplied will increase.

Theoretically, when the demand and supply increases together the effect on the prices will be cancelled out.

But practically this will depend on the level of price plunge and the total demand.


13

The impact of oil prices on the Malaysian economy

Malaysian Oil industry

According to MPC (2014) in the past, Malaysian oil and gas industry was dominated by foreign companies

like Shell & Esso and later the state-run energy group PETRONAS which came to existence with the

passing of Petroleum Development Act in 1974 took control over.

According to BBC’s (2015) article, Malaysia being South East Asia's third-largest economy, it is a major

exporter and producer of petroleum products.

(Source: tradingeconomics.com)

The plunging oil prices have affected Malaysia’s national income to decrease, but did not lose substantial

revenue as the country is not a major oil exporter. Kamari (2015) article states that Malaysia is more of an

importer of crude oil & petroleum.

0

100

200

300

400

500

600

700

587 586560 562 577

613

670 671 680 693 6976751

Kb

/d

Malaysia Crude oil production


14

In 2014, Malaysia’s imports amounted to US$ 25.5

billion while exports were US$ 24.1 billion

(Kamari, 2015). This loss of national revenue due to

plunging oil prices is around US$ 330 million

which can be accommodated through reducing

governments operating costs such as fuel subsidies.

BBC (2015) article states that Malaysian Finance

minister Mr. Najib said, the revised budget assumed

that crude oil would trade at about US$ 55/barrel

and the prices are beyond their control.

Beside oil production, tourism and education has its shares on the Malaysia’s economy. Malaysia offers

Cultural, adventure, medical, beach and agricultural tourism to the globe and is promoted as “Malaysia, truly

Asia”.

Arrivals in millions & revenue in billions US$

(Source: corporate.tourism.gov)

25.5

24.1

23

23.5

24

24.5

25

25.5

26

Imports Exports

US$

Billion

Import & export of oil in 2014

Imports

Exports

24.58 24.71 25.03 25.72 27.44

56.5 58.3 60.665.44

72

2010 2011 2012 2013 2014

Tourist arrivals & revenue generated 2010 to 2014

Arrivals Revenue


15

Since Malaysian economy does not solely depend on oil, the deficits can be neutralized by other sources of

revenue from other industries. Thus the plunging oil prices may not harm Malaysia’s whole economy.

(Source:idrisjala.my)

Malaysia is not a big player in oil trade compared to the oil rich Middle East. Malaysia produces 642700 b/d

and is on 28th in the world ranking while the top most Saudi Arabia produces 11,730,000 b/d and has a

reserve of more than 260 billion barrels (indexmundi.com).

The oil rich Arab nations have absolute advantage in oil production since resources are naturally inherited

and are easily accessible through land. Malaysia’s oil production largely depends on exploration in their deep

waters. Saudi Arabia specializes in oil production due to the easy accessibility and fairly attractive labor

market comprising of foreign workers with relatively low labor costs. Oil industry proves to be the

stronghold of Saudi Arabia’s economy and control on global market. Therefore investing in other fields such

as tourism, the opportunity costs for Saudi Arabia can be relatively high.

Other industries30%

Oil, Gas & Energy17%

Wholesale & Retail14%

Financial Services7%

Palm oil / Rubber7%

Agriculture6%

Tourism5%

Electric & Electronic5%

Business Services4%

Communication & infrastructure

3%

Healthcare 1% Education

1%

GDP Composition Malaysia


16

Exploration and production of oil in Malaysia is carried out under Production Sharing Contracts (PSC)

whereby the companies are granted exploration rights by PETRONAS, obligating the contractor to provide

total financing and bear all the risks of exploration and development in exchange for a share of total

production and there are currently more than 70 PSC’s (MPC, 2014).

Malaysia specializing in oil production does not obligate the state to higher opportunity costs since the PSCs

cover the financing and risk bearing in oil production. Oil production does not hold the major share while

other industries contributes well to Malaysia’s GDP.

Hence, Malaysia has comparative advantage in specializing in the oil exploration and production without a

huge opportunity cost along with its other industries side by side to serve the total GDP.


17

Effects of depreciating Ringgit value & inflation on Malaysian Economy

Vulcan post (2015) article states that Malaysia’s ringgit value has slid past 4.0 against US dollar in the worst

currency crash seen for the first time in 17 years. The main culprit however, is the decreasing oil prices

which destabilizes the oil-exporting economy.

Bank Negara Malaysia states that Ringgit exchange buying rate for US$ is 4.30 while the selling rate is 4.31.

Exchange rate Malaysian Ringgit to US$

There are several factors causing Ringgit to fall against the US dollar such as the higher demand for the

dollar itself and as well, the perception that Malaysia will be affected badly with the plunging oil prices

(Kamari, 2015) . The depreciating Ringgit exchange rate for US$ can have several effects on the economy.

Simply a depreciation means the currency can buy less foreign exchange, thus the imports become expensive

whereas the exports cheaper. This can result imported inflation as the prices of imported goods will rise. The

increase in expenses incurred to import goods will decrease the supply and eventually increase the prices of

imported goods whereas the falling Ringgit value against US dollars can increase the demand for Malaysia’s

exports. Cheaper exports can result increase in domestic aggregate demand.

(Source: Exchangerates.org.uk)


18

Higher domestic aggregate demand can cause higher economic growth since, imports and exports are a part

of aggregate demand. Falling currency value can result in lower imports and higher exports, increasing the

aggregate demand ultimately causing demand pull inflation.

Demand pull inflation

When a disequilibrium occurred at P* and Y* due to the

increase in aggregate demand a new equilibrium is

forced at P1 and Y1. This increases the prices from P*

to P1.

The quantity increased from Y* to Y1, thus to increase

supply, more expenses on imports have to be incurred

due to plunging currency value. Thus the prices will

increase and result in demand pull inflation.

The cost of domestic production may also rise due

to the rising cost of imported raw materials. This

can make the production more costly and result in

lower output which can result prices to rise,

eventually followed by cost push inflation.

Cost push inflation is a possible cause of

stagflation, in which the output will fall at the

same time prices will keep rising.

Chew (2015) article states that the introduction of

a 6% GST in April has also pressured on domestic

prices alongside the prices of imported goods.

3.17

1.66

2.11

3.14

2.7

0

0.5

1

1.5

2

2.5

3

3.5

2011 2012 2013 2014 2015

Malaysia's inflation rates


%

AS

P 1

AD

Price

P *

AD 1

Y * Y 1 Quantity


19

Cost Push inflation

When a disequilibrium occurred at P* and Y* due to

the shortage of supply as a result of decreasing

output (due to the increasing cost of production) the

quantity supplied decreased from Y* to Y1 and the

prices increased from P* to P1 forming a new

equilibrium.

The quantity of output decreased while the price

increased resulting stagflation.

Thus in such a situation Malaysia is likely to experience both demand pull inflation and cost push inflation.

Since the value of Ringgit is expected to continue to fall, people trying to purchase more before the fall can

increase the demand thus worsen the inflation.

AD

AS

P *

P 1

Y * Y 1

Price

Quantity

AS 1


20

Negative effects of plunging oil prices & Ringgit value on Malaysian

Economy

Malaysia being a price taker in oil industry, plunging oil prices can have its heavy deficits on Malaysia’s

economy. The falling prices can result in oil exports revenue to fall and central banks reserves to shrink.

Stratfor (2015) article states that Malaysia is the second largest energy producer in Southeast Asia and is the

country most threatened by the plunging oil prices. Due to the falling trend of oil prices, PETRONAS has

announced it would reduce its total payments to the government in 2015. Thus in such situations the

government has to decrease the planned spending.

Chandran (2015) article states that sharp currency depreciation and introduction of GST, are widely expected

to drag 2015 GDP growth below 5% from the estimated 5.8% in 2014.

The depreciating currency value can increase the aggregate demand thus increase inflation. The hard hit on

the prices of consumer goods and falling export revenue can worsen the economic situation unless it’s

countered with efficient state policies.

Inflation, if not handled properly can lead to a recession which can be very harmful to the entire economy.

Recession can be defined as a period of negative economic growth for two or more consecutive quarters.

When an economy experiences cost push inflation, there are chances of an impending recession. Since

Malaysia is likely to experience both demand pull & cost push inflation they may be leading to a recession.

The imported inflation and introduction of GST in Malaysia will rise the commodity prices. This will affect

the consumer’s disposable income. Thus the pressure on living standards can lead to lower growth and

aggregate demand.

In such situations to cut costs, firms and industries may also cut down investments which may further push

the economy into a recession. During recessions, economies often experiences rising of unemployment and

decrease in overall output.


21


Nitisha (2015) states that since inflation is a complex situation, if it goes beyond a moderate rate it can

create disastrous situations for an economy, thus it should be controlled.

There are several measures to control inflation, such as monetary, fiscal measures or price controls that can

be implied by the state.

Monetary policy is one of the commonly implied measures to control inflation. In monetary measures

governments formulate policies to counter the economic issues by controlling money circulation in the

economy.

The fiscal measures comprises of government’s revenue and expenditures. To control inflation, in such

measures government formulates policies either to reduce spending or decrease state expenditures.

Implying price controls by the government can suppress inflation for a while, but doesn’t serve the purpose

for a longer term. Price controls itself cannot control inflation instead it can reduce the extent of inflation.

Thus in such circumstances the Malaysian government shall come up with a macroeconomic policy mix

which can tackle the economic issues from worsening and help to regain a healthy economy.

When formulating a policy mix, the government shall take into consideration the relation between the goods

and the money market. The interactions between these two markets are very straightforward. The interest

3.053.03

3.1

2.9

3

2.8

2.85

2.9

2.95

3

3.05

3.1

3.15

2011 2012 2013 2014 2015

Unemployment rate malaysia 2011-2015%


22

rates are always determined by the money market where the demand for money is affected by the income, the

goods market determines the income which depends on planned investments while the planned investments

are dependent on the interest rates.

There are two monetary and two fiscal policies which can be implemented to counter the inflation. They are:

a) Expansionary monetary policy

b) Contractionary monetary policy

c) Expansionary fiscal policy

d) Contractionary fiscal policy

These policies are very much related to the Aggregate expenditure of the economy. Aggregate Expenditure

can be calculated through the formula AE= C + I + G + (X-M).

C = consumption

I = investment

G = government spending

(X-M) = exports less imports.

Expansionary monetary policy

In this policy the government may either reduce

reserve ratio, lowers the discount rates or buy

bonds. This can result increase in money supply

in the circulation reducing interest rates,

increase investments & expenditure, increase

income and employment.

As per the graph when the money supply

increased from MS to MS1 the money demand

decreased where the interest rates fell from R* to

R1.

MD

R 1

R *

Interest

Rates

MS MD

MS 1 MS


23

Contractionary monetary policy

In this policy the government may sell bonds

and collect money to decrease money supply

in the circulation. This can result in higher

interest rates due to the reduction in money

circulating in the economy while the reserve

will increase.

As per the graph when the money supply

decreased from MS to MS1 the money demand

rises increasing the interest rates to R1 from

R*.

Expansionary fiscal policy

This policy is designed to stimulate the economy

during growth contractions. This policy can help

increase the aggregate demand since government

increases spending or decreases taxation.

As per the graph, when the government increased

its spending the aggregate expenditure increased

from AE to AE 1. The output increased from Y* to

Y1

MD

R *

R 1

Interest

Rates

MS MD

MS

MS 1

AE

Goods

market

Y

AE 1

Y 1 Y *


24

Contractionary fiscal policy

In this policy the government seeks to decrease the

aggregate expenditure and aggregate demand

through decreasing government spending or

increasing taxation. This helps reducing budget

deficits.

As per the graph, when the government decreased

spending the aggregate expenditure decreased

from AE to AE 1. The output decreased from Y* to

Y1

Implementing of fiscal policies, the initial effect takes place in the goods market whereas in monetary

policies it starts in money market.

Macroeconomic policy mix

In a situation where the oil prices are plunging and currency value depreciating at the same and increasing

inflation, government should take into consideration the production of oil and the circulation of money in the

economy.

To tackle the current economic situation in Malaysia, a combination of Expansionary fiscal policy with

Contractionary monetary policy can be suggested as an effective macroeconomic policy mix.

AE 1

Goods

market

Y

AE

Y * Y 1


25

The possible effects of expansionary fiscal and Contractionary monetary policy on the goods and the money

market

As per the graph when the government increased its spending or decreased the taxation, the aggregate

expenditure and the total output increased while the Contractionary monetary policy reduced the amount of

money circulating in the economy by decreasing the money supply which resulted in interest rates to rise.

The Expansionary fiscal policy accommodated with a Contractionary monetary policy can result the

currency value to appreciate. This is good for the depreciating Malaysian Ringgit. Yet at the same time it can

deteriorate the state current account.

The increase in aggregate expenditure can result greater budget deficits due to tax cuts or increased

government spending. The expansionary fiscal policy with Contractionary monetary policy can cause the

interest rates to rise. This rise can lead to capital inflows and currency value to appreciate.

The higher interest rates can increase the capital inflows as foreigners purchase domestic financial assets.

This can strengthen the capital account. As the foreign investments needs to exchange foreign currency for

the domestic currency, the increased demand for the Malaysian Ringgit in this case, will cause its exchange

rates to rise. Therefore the falling Ringgit value will appreciate.

The increasing aggregate expenditure and appreciating currency value can fight unemployment and increase

the total output. Thus can counter cost push inflation reducing the chances of a stagflation in the Malaysian

economy.

AE

Goods

market

Y

AE 1

Y 1 Y *

MD

R *

R 1

Interest

Rates

MS

MS MS 1


26

The appreciating domestic currency value will result exports to decrease making it less attractive to foreign

markets and imports will increase making it less expensive to the state’s consumers and local businesses.

In the implementation of such a policy mix, the government shall consider the balance-of-payment to keep

the current account from being totally deteriorated. Increase or decrease of either exports or imports

significantly can weaken the trade balance of the country, which may not be desirable for the economy. As

well the net effect of the combined policies, on the aggregate demand, GDP and the price levels highly

depends on the magnitude of the two effects caused by the Expansionary fiscal and Contractionary monetary

policy.

Externalities of provision of education, tourism and healthcare in Malaysia

According to Business dictionary (2015) externalities are a loss or gain in welfare of one party resulting from

an activity of another party, without there being any compensation for the losing party.

There are positive and negative externalities resulting from economic activities. A positive externality can

occur when production or consumption of a certain good or service causes benefits for a third party. For

example: education. A negative externality can be a harmful effect to a third party due to production or

consumption of a certain good or service. For example: burning of garbage in a dump yard causing air

pollution.

In almost every economic activity carried out, there can be positive and negative externalities resulting along

with the output.

Malaysia’s private sector provides education, tourism and health care facilities. These activities as

mentioned before, contribute 1%, 5% and 1% to the economy and GDP respectively.

When dealing with externalities governments can support positive externalities by providing subsidies,

quotas and etc which will ultimately increase the output and total well-being of the community as a whole

whereas to deal with the negative ones government can restrict by increasing taxation and reduction of

quotas and so.


27

Positive externalities of education

o More educated individuals usually are more productive

o Public schools providing mandatory education provides every child the chance to learn

o Public education helps redistribution

o More educated society means more civilized thus less crime and odd actions

Positive externalities of tourism

o Can preserve natural landscapes which can be otherwise used to industrial development

o Chances to experience unusual cultures which can be informative and profitable for the community

o Creates more employment and close the gap between cultures and religions

Positive externalities of health care

o An effective healthcare can lead to a positive economic gains through a healthy labor force

o Vaccination process helps the particular individual from getting infected from certain diseases while

it reduce the likelihood of other individuals contracting the disease

Beside these positive externalities there are negative externalities in these activities as well. For example:

offshore giant corporations operating in tourism market can funnel out revenues from local companies,

western fashion and trends can threaten the distinct lifestyles and local cultures. In health sector, great deal

of chemical waste can cause environmental degradations.

However a cost-benefit analysis advocates that the positive externalities of education, tourism and health

care turn out to be of more weight in production and consumption in the Malaysian economy.

For example: Higher education provision in Malaysia has numerous foreign candidates enrolled in their

universities which increases the inflow of foreign currency into the economy. Tourism and health facilities

on the other hand plays very well in foreign exchange inflows in relation to the consumption from foreigners.

Subsidizing economic activities can increase the total output and decrease the costs of production which can

result prices to fall. This can even increase employment since manufacturers may produce to their maximum

capacity due to the government support and assistance through subsidization.


28

For example:

Before subsidization

According to the graph there’s a

clear shift to the right of PMB

curve to the SMB as a result of a

positive externality. For example:

In education sector this can be

due to the more productive

individuals whereas in health

sector it can be due to more

healthier people thus a healthy

and reliable workforce. The

social marginal benefit as a

result of positive externality it has

a potential welfare gain, thus the

SMB is greater than SMC. As the

PMB shifted to right the quantity

increases to Q1 which is the

socially optimum level. But the

prices increased to P1 from P*.

After subsidization

In the diagram, the SMC has

shifted to the black curve showing

the costs after provision of

subsidy. Shifting of SMC to the

right, the social optimum level Q1

has been achieved at the price P2

which is significantly low.

Government’s subsidy resulted

the positive externality to retain

at a lower price for the consumer.

Hence, the quantity increased

while the price decreased.

D = PMB

P 2

P *

Q *

Price

Quantity

SMB

P 1

Q 1

Potential gain

D = PMB

P 2

P *

Q *

Price

Quantity

SMB

P 1

Q 1

Government subsidy


29

Therefore, considering the positive externalities resulting from the production and consumption of these

services which profits the whole community directly and indirectly, the government shall subsidize these

economic sectors. Subsidization supports the production which ultimately increases the output and decreases

the costs incurred and the prices.

CONCLUSION

The global and local oil production and price of oil can have its positive and negative effects on any

economy since, each and every country requires energy to its industrial productions and survival. Malaysian

economy also has had to face the deficits of plunging oil prices. Malaysia being a price taker in the global oil

market, there’s no broad control in the global oil industry and market.

The export of oil and the policy on production through PSC’s have been favorable to Malaysia. The

depreciating Ringgit value is alarming since this can affect the total output and the aggregate demand of the

Malaysian economy. A sound macroeconomic policy mix if implemented well considering the level of

effects through the combination of monetary and fiscal policy can save the Asia’s second largest energy

producer from heading to a recession.


30

References and sources

BBC (2015) Malaysia cuts 2015 growth forecast on oil price fall. [Online] 20th January 2015. Available at:

http://www.bbc.com/news/business-30892591 (Assessed: 2nd November 2015)

Bowler, T. (2015) Falling oil prices: Who are the winners and losers? BBC. [Online] Available at:

http://www.bbc.com/news/business-29643612 (Assessed: 26th October 2015)

Business dictionary (2015) Externalities. Available at:

http://www.businessdictionary.com/definition/externalities.html (Assessed: 8th November 2015)

Chandran, N. (2015) It’s not just oil: Trouble brews for Malaysia. CNBC. [Online] 7th January 2015.

Available at: http://www.cnbc.com/2015/01/07/its-not-just-oil-trouble-brews-for-malaysia.html (Assessed:

5th November 2015)

Chew, E. (2015) Malaysia’s Ringgit falls as inflation increases rates-rise odds. Bloomberg Business. [Online]

19th August 2015. Available at: http://www.bloomberg.com/news/articles/2015-08-19/ringgit-falls-with-

bonds-as-inflation-may-spur-policy-response (Assessed: 3rd November 2015)

Country comparison (2014) Oil production – Top 50 [Online] Available at:

http://www.indexmundi.com/g/r.aspx?t=50&v=88&l=en (Assessed: 4th November 2015)

Country health plan (2010) 10th Malaysian Plan (2011-2015) [Online] Available at:

http://www.moh.gov.my/images/gallery/Report/Country_health.pdf (Assessed: 15th November 2015)

IEA (2015) Oil Market Report Highlights, October 2015. Available at:

https://www.iea.org/oilmarketreport/omrpublic (Assessed: 26th October 2015)

IMF (2015) Impact of falling oil prices on IMF membership 2015. Available at:

http://www.imf.org/external/pubs/ft/ar/2015/eng/spotlight-oil.htm (Assessed: 26th October 2015)

Jala (2015) Staying the course. [Online] 4th May 2015 Available at: http://idrisjala.my/tag/gdp/ (Assessed: 2nd

November)

Kamari, E. (2015) Oil prices, government’s revenue and Malaysia’s economy – Pt 1. The establishment post.

[Online] 21st March 2015. Available at: http://www.establishmentpost.com/oil-prices-government-revenue-

malaysias-economy-pt-1/ (Assessed: 1st November 2015)

Krauss, C. (2015) Oil price: What’s behind the drop? Simple economics. The New York Times. [Online] 5th

October 2015. Available at: http://www.nytimes.com/interactive/2015/business/energy-environment/oil-

prices.html?_r=0 (Assessed: 26th October 2015)

Malaysia Productivity Corporation (2014) Gas and oil sector 2014 [Online]. Available at:

http://www.mpc.gov.my/mpc/images/file/RR2014/Oil%20and%20Gas/Chap2.pdf (Assessed: 1st November

2015)

Ministry of tourism and culture Malaysia (2014) Special tourism fund 2014 [Online] Available at:

http://www.motac.gov.my/en/programme/funds-incentives/special-tourism-fund (Assessed: 14th November

2015)

http://www.bbc.com/news/business-30892591

http://www.bbc.com/news/business-29643612

http://www.businessdictionary.com/definition/externalities.html

http://www.cnbc.com/2015/01/07/its-not-just-oil-trouble-brews-for-malaysia.html

http://www.bloomberg.com/news/articles/2015-08-19/ringgit-falls-with-bonds-as-inflation-may-spur-policy-response

http://www.bloomberg.com/news/articles/2015-08-19/ringgit-falls-with-bonds-as-inflation-may-spur-policy-response

http://www.indexmundi.com/g/r.aspx?t=50&v=88&l=en

http://www.moh.gov.my/images/gallery/Report/Country_health.pdf

https://www.iea.org/oilmarketreport/omrpublic

http://www.imf.org/external/pubs/ft/ar/2015/eng/spotlight-oil.htm

http://idrisjala.my/tag/gdp/

http://www.establishmentpost.com/oil-prices-government-revenue-malaysias-economy-pt-1/

http://www.establishmentpost.com/oil-prices-government-revenue-malaysias-economy-pt-1/

http://www.nytimes.com/interactive/2015/business/energy-environment/oil-prices.html?_r=0

http://www.nytimes.com/interactive/2015/business/energy-environment/oil-prices.html?_r=0

http://www.mpc.gov.my/mpc/images/file/RR2014/Oil%20and%20Gas/Chap2.pdf

http://www.motac.gov.my/en/programme/funds-incentives/special-tourism-fund


31

Nitisha (2015) Measures for controlling inflation. [Online] Economics Discussions. Available at:

http://www.economicsdiscussion.net/inflation/measures-for-controlling-inflation-with-diagram/4075

(Assessed: 7th November 2015)

OPEC (2014) Annual report 2014. Available at:

http://www.opec.org/opec_web/static_files_project/media/downloads/publications/Annual_Report_2014.pdf

(Assessed: 26th October 2015)

OPEC (2015) Monthly oil market report, October 2015. Available at:

http://www.opec.org/opec_web/static_files_project/media/downloads/publications/MOMROctober2015.pdf

(Assessed: 27th October 2015)

Seiminski, A. (2015) Effects of low oil prices. [Power point presentation]. Energy information

administration 2015. Available at:

http://www.eia.gov/pressroom/presentations/sieminski_02262015_csis.pdf (Assessed: 30th October 2015)

SELECTUSA (2015) The automotive industry in the United States 2015. Available at:

http://selectusa.commerce.gov/industry-snapshots/automotive-industry-united-states.html (Assessed: 26th

October 2015)

Statista (2015) Malaysia: Inflation rate from 2010 to 2020 (compared to the previous year). Available at:

http://www.statista.com/statistics/319033/inflation-rate-in-malaysia/ (Assessed: 3rd November 2015)

Statista (2015) Malaysia: Unemployment rate from 2010 to 2020. Available at:

http://www.statista.com/statistics/319019/unemployment-rate-in-malaysia/ (Assessed: 3rd November 2015)

Statista (2015) Motor vehicle production of the United States and worldwide from 1999 to 2014. Available

at: http://www.statista.com/statistics/198488/us-and-global-motor-vehicle-production-since-1999/ (Assessed:

30th October 2015)

Stratfor (2015) How Low Oil Prices Will Impact Southeast Asia. [Online] 4th February 2015. Available at:

https://www.stratfor.com/analysis/how-low-oil-prices-will-impact-southeast-asia (Assessed: 5th November

2015)

Tourism Malaysia (2015) Tourist arrival and receipts to Malaysia. [Online] Available at:

(http://corporate.tourism.gov.my/images/research/tourist_arrival_receipts.jpg) (Assessed: 1st November

2015)

Varjavand, R. (2015) Falling crude oil prices’ impact on US economy. Chicago Tribune. [Online] 13th March

2015. Available at: http://www.chicagotribune.com/suburbs/daily-southtown/opinion/ct-sta-varjavand-

column-st-0315-20150313-story.html (Assessed: 30th October 2015)

Vulcan post (2015) Positive and negative of the Ringgit’s shameful fall that you didn’t think about. [Online]

Available at: https://vulcanpost.com/343181/positive-negative-effect-fall-ringgit/ (Assessed: 1st November

2015)

http://www.economicsdiscussion.net/inflation/measures-for-controlling-inflation-with-diagram/4075

http://www.opec.org/opec_web/static_files_project/media/downloads/publications/Annual_Report_2014.pdf

http://www.opec.org/opec_web/static_files_project/media/downloads/publications/MOMROctober2015.pdf

http://www.eia.gov/pressroom/presentations/sieminski_02262015_csis.pdf

http://selectusa.commerce.gov/industry-snapshots/automotive-industry-united-states.html

http://www.statista.com/statistics/319033/inflation-rate-in-malaysia/

http://www.statista.com/statistics/319019/unemployment-rate-in-malaysia/

http://www.statista.com/statistics/198488/us-and-global-motor-vehicle-production-since-1999/

https://www.stratfor.com/analysis/how-low-oil-prices-will-impact-southeast-asia

http://corporate.tourism.gov.my/images/research/tourist_arrival_receipts.jpg

http://www.chicagotribune.com/suburbs/daily-southtown/opinion/ct-sta-varjavand-column-st-0315-20150313-story.html

http://www.chicagotribune.com/suburbs/daily-southtown/opinion/ct-sta-varjavand-column-st-0315-20150313-story.html

https://vulcanpost.com/343181/positive-negative-effect-fall-ringgit/


32

Documents

Assignment report Economics Analysis